Tax Implications of Real Estate Gifting Strategies

If you’re debating whether to gift a home to your children or grandchildren early or to bequeath it upon death, then you’ll want to read this article. There are important pros and cons to both strategies, mainly related to taxes. Below, we take a look at both scenarios and the tax implications of real estate gifting strategies.

Gifting Property Early

There are two ways to gift a property early. You can transfer it all at once or a little bit each year (to stay within the $15,000 per person gift exemption limit). For this example, let’s assume you have 2 kids, no mortgage, and you’re gifting gradually. 

Both you and your spouse are allowed to gift each child 15k per year. So, that allows you to transfer $30k of the property’s value to each child per year, or $60k total. If your home is worth $400k, it will take you 7 years to transfer the full value. Each year, you would need an appraisal confirming the property’s value and a new deed indicating their increased ownership in the property (relative to yours). 

This gifting strategy will avoid gift taxes since you’re staying within the annual limits. However, it’s important to note that your children may be responsible for higher capital gains taxes in the future. Here’s why.

Capital gains taxes on the sale of a property is calculated using the sale price minus the base value. In the case of a gradual transfer, that base value is what you originally purchased the home for, plus capital improvements (not the value at the time of their ownership). So, if you bought the home many years ago for $100k, it’s $400k when they received ownership but $500k when they sell, your children would be paying capital gains on $500k minus $100k. The value at the time of full ownership doesn’t matter. Assuming a tax rate of 15%, that’s $60k in capital gains tax. Let’s now compare this to a transfer upon death. 

Gifting Property Upon Death

Alternatively, if you opted to gift a property upon your death, tax calculations would be slightly different. Depending on the overall value of your estate, estate taxes may apply. For simplification purposes, let’s set aside that factor for now and look at just the capital gains piece.

Under current law, the tax basis for real estate sale is “stepped up” when a property is inherited. Thus, the value on the day you died is used to calculate capital gains. Let’s assume the value is $400,000 when you died and $500,000 when your children decide to sell. That’s $100k in capital gains and $15,000 in taxes (compared to the $60k in taxes in the prior example). 

Comparing Tax Implications of Real Estate Gifting Strategies

If we look strictly at capital gains, early gifting is clearly less beneficial. However, estate planning is rarely that simple. Other aspects of your estate and your overall value must be considered. Whether your children occupy the home as a primary residence and qualify for additional tax exemptions will also be a factor in their tax liability. Before you decide on a gifting strategy for real estate that you own, sit down with our team to discuss your overall estate and the full range of options available. The above are just two examples of tax implications of real estate gifting strategies.